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How to improve consumer lending

Jamie Thunder, Policy & Communications Officer at The Money Charity, blogs about proposals to improve best practice in lending

Did you know that a credit card you’re no longer spending on could take decades to pay off, even if you never miss a payment?

That’s because as the amount you owe reduces, so too does the card’s minimum payment. This has to cover any interest and charges you’ve racked up in the month, and either a fixed sum of, say, £5, or 1% of the amount you owe, whichever is higher (some cards might require you to pay off a higher percentage).

So if you owe £10,000 on a credit card, you’d have to pay a minimum of £100 plus any interest/charges in the first month, then £99 the second, £98 the third, and so on.

That might not seem like a big difference, but it adds up. The UK Cards Association has a handy calculator – so we used this, along with figures from our Money Statistics, to take a look.

The average household has a credit card debt of £2,292, and the average rate of interest on a credit card is 17.91% APR. Plugging that into the calculator, we find that just making the card’s minimum payment means you’d repay the card in 25 years and three months.

But if you paid the contractual minimum payment in the first month then kept paying that amount, you’d clear it in 5 years and 3 months – a full TWENTY YEARS sooner!

Here’s a nice graph to illustrate it:

When you see it like that, it’s shocking – consumers can end up almost endlessly in debt. So in our response this week to the independent review of the Lending Code, we’ve said that the automatic minimum payment shouldn’t reduce from the highest it’s been on that card unless you’ve specifically requested it. After all, if you’ve repaid it one month, there’s a reasonable chance you’ll be able to keep up that level of repayment.

Of course in real life, people’s budgets – and ability to repay that higher minimum – do fluctuate. Real life can be messy! So we do think you should be able to contact your lender and ask them to pay less than that minimum if you need to. But if you do that, they shouldn’t just stick you back on the contractual minimum payment. They should discuss with you how setting your repayments to something above the contractual minimum could still clear your debt much earlier.

To illustrate this, here’s how the graph above looks if you pay the automatic minimum for two years, then drop down to £40 payments for two years, then to £30 until the balance is clear:

This frees up more of your money over time – while paying off your debt quicker. Although you’ll still be repaying for a while, you’d be debt-free in less than half the time than if you’d just made those contractual minimum repayments!

The Lending Code is the industry’s code of practice, and is sponsored by the British Bankers Association, the Building Societies Association, and the UK Cards Association. So it should set the gold standard for firms’ practices, above and beyond what the Financial Conduct Authority requires. Reforming the minimum payment system is just one of the measures this should include – we’ve outlined a couple of others below.

Putting consumers in control

As well as changing the way minimum payments work, we think consumers should be put in control of their credit card and overdraft limits – something we’ve previously said should be a rule for all credit providers.

At the moment, if a credit card company wants to increase your limit the onus is on you to reject it. This should be reversed, so you only get additional credit if you have explicitly agreed to it.

The same should happen when you apply for a credit card. It’s pretty common to enter a requested limit then be offered something much higher. This should only happen if the amount you’ve requested is below the ‘floor’ of what the firm is willing to lend – not as standard.

Identifying financial difficulty

The Lending Code also sets out indicators that someone might be in financial difficulty. We think this needs to be expanded to include people who are continuously making the very minimum repayment on their credit card debt while still being charged interest on that card.

That doesn’t mean that they’re definitely in trouble – but they might be, and firms should contact the customer to check. Figures from StepChange show that half of their clients think their debt’s a problem for more than a year before they get any help, so there’s clearly more that industry can do to proactively contact people and stop problems developing at an early stage.